1. An inflationindexed Treasury bond has a par value of $1,000 and a coupon rate of 6 percent. An investor purchases this bond and holds it for one year. During the year, the consumer price index increases by 1 percent every six months. What are the total interest payments the investor will receive during the year?

2. Assume that the U.S. economy experienced deflation during the year and that the consumer price index decreased by 1 percent in the first six months of the year and by 2 percent during the second six months of the year. If an investor had purchased inflation-indexed Treasury bonds with a par value of $10,000 and a coupon rate of 5 percent, how much would she have received in interest during the year?

3. Assume the following information for an existing bond that provides annual coupon payments: Par value ¼ $1,000 Coupon rate ¼ 11% Maturity ¼ 4 years Required rate of return by investors ¼ 11% a. What is the present value of the bond?

b. If the required rate of return by investors was 14 percent instead of 11 percent, what would be the present value of the bond? c. If the required rate of return by investors was 9 percent, what would be the present value of the bond?

4. Valuing a Zero-Coupon Bond Assume the following information for existing zero-coupon bonds: Par value ¼ $100,000 Maturity ¼ 3 years Required rate of return by investors ¼ 12% How much should investors be willing to pay for these bonds?

5. Assume that you require a 14 percent return on a zero-coupon bond with a par value of $ 1,000 and six years to maturity. What is the price you should be willing to pay for this bond?

6. Cardinal Company, a U.S.-based insurance company, considers purchasing bonds denominated in Canadian dollars, with a maturity of six years, a par value of C$50 million, and a coupon rate of 12 percent. Cardinal can purchase the bonds at par. The current exchange rate of the Canadian dollar is $0.80. Cardinal expects that the required return by Canadian investors on these bonds four years from now will be 9 percent. If Cardinal purchases the bonds, it will sell them in the Canadian secondary market four years from now. It forecasts the exchange rates as follows:

YEAR EXCHANGE RATE OF C$ YEAR EXCHANGE RATE OF C$

1 $0.80 4 $0.72

2 0.77 5 0.68

3 0.74 6 0.66

a. Refer to earlier examples in this chapter to determine the expected U.S. dollar cash flows to Cardinal over the next four years.

b. Does Cardinal expect to be favorably or adversely affected by the interest rate risk? Explain.

c. Does Cardinal expect to be favorably or adversely affected by exchange rate risk? Explain.

7. (Use the chapter appendix to answer this problem.) Bulldog Bank has just purchased bonds for $106 million that have a par value of $100 million, three years remaining to maturity, and an annual coupon rate of 14 percent. It expects the required rate of return on these bonds to be 12 percent one year from now.

a. At what price could Bulldog Bank sell these bonds one year from now?

b. What is the expected annualized yield on the bonds over the next year, assuming they are to be sold in one year?

8. (Use the chapter appendix to answer this problem.) Sun Devil Savings has just purchased bonds for $38 million that have a par value of $40 million, five years remaining to maturity, and a coupon rate of 12 percent. It expects the required rate of return on these bonds to be 10 percent two years from now.

a. At what price could Sun Devil Savings sell these bonds two years from now?

b. What is the expected annualized yield on the bonds over the next two years, assuming they are to be sold in two years?

c. If the anticipated required rate of return of 10 percent in two years is overestimated, how would the actual selling price differ from the forecasted price? How would the actual annualized yield over the next two years differ from the forecasted yield?

9. (Use the chapter appendix to answer this problem.) Spartan Insurance Company plans to purchase bonds today that have four years remaining to maturity, a par value of $60 million, and a coupon rate of 10 percent. Spartan expects that in three years, the required rate of return on these bonds by investors in the market will be 9 percent. It plans to sell the bonds at that time. What is the expected price it will sell the bonds for in three years?

10. (Use the chapter appendix to answer this problem.) Hankla Company plans to purchase either (1) zero-coupon bonds that have 10 years to maturity, a par value of $100 million, and a purchase price of $40 million; or (2) bonds with similar default risk that have five years to maturity, a 9 percent coupon rate, a par value of $40 million, and a purchase price of $40 million. Hankla can invest $40 million for five years. Assume that the market’s required return in five years is forecasted to be 11 percent. Which alternative would offer Hankla a higher expected return (or yield) over the five-year investment horizon?